Case Law Details
In the case of:- IL Jin Electronics (I) Pvt. Ltd. Vs. Asst. Commissioner of Income Tax [ITA No. 438/Del/2008]
Facts of the Case
- Established in September, 2001, IL Jin Electronics (I) Pvt. Ltd. (IL Jin/ Taxpayer) is engaged in the business of manufacturing & selling printed circuit boards for consumer durables. It commenced commercial production in January, 2002. During FY 2002-03, for its operations, the Taxpayer entered into various international transactions (See Note 1 below) with its AEs, with the bulk of international transactions being that of purchase of raw material.
- Out of the total raw material consumed, imported raw material constituted of 45.51% and the rest was indigenous raw material (i.e. 54.49%).
- Based on the transfer pricing study, Transactional Net Margin Method (TNMM) using net profit margin on sales (NPM) as a profit level indicator (PLI), was selected to be the most appropriate method to evaluate the international transactions. Thereafter, on a basis of a comparable search, the Taxpayer had selected 8 comparable companies with an arithmetic mean margin of (1 1.12)%.
- During the audit proceedings, the TPO objected to two of the com parables, namely Hyderabad Flex tech Limited (HFL) and Sanmar Micropak Limited (SML), which had high negative net margins. Finally, post discussions with the Taxpayer, HFL & SML were rejected by the TPO due to the reasons given below:
– HFL: was rejected as the Taxpayer itself stated that the same was not considered for calculating the average margin on a single year basis.
-SML: was rejected as it had negative net worth and high negative margin during the relevant year.
- Accordingly, on the basis of average margin earned by the remaining 6 companies i.e., 5.29% vis-à-vis that earned by the Taxpayer i.e., 1.65%, the TPO made a downward adjustment to IL Jin’ s international transaction of import of raw material and held other international transactions at arm’s length. In light of the TPO’s order, the AO made additions to IL Jin’s taxable income.
- Subsequently, the CIT(A) upheld the TPO’s order. Aggrieved by the decision of the CIT(A), IL Jin filed appeal with the Tribunal against the order of the CIT(A).
Issues, Contentions and Tribunal’s Ruling
Issue 1: Use of CPM/ RPM with AE as the tested party to benchmark the impugned international transaction
Taxpayer’s Contention: Contended that comparable analysis of purchase prices of individual items paid by the AE to unrelated foreign vendors and supplied to LG Electronics in Korea and Thailand should be considered to analyze the said transaction.
Revenue’s Contention:
- There exists no internal comparable uncontrolled transaction.
- The Taxpayer has not been able to point out any ‘irregularity’ or ‘deficiency’ with the TPO’s approach.
- The approach followed by the TPO is consistent with that of the Taxpayer as documented in its transfer pricing report. Further, the Taxpayer has not provided any documentary support for the analysis being suggested by it.
- In addition, under similar facts of the case, in the subsequent assessment years TNMM has been selected as the most appropriate method.
Tribunal’s Ruling: Having regard to the facts and circumstances and absence of sufficient material and evidence to apply another method, the Tribunal concurred with CIT(A) (See Note 2) in holding TNMM as the most appropriate method.
Issue 2: Adjustment for supply of raw-material from the AE on credit
Taxpayer’s Contention: NPM earned by the Taxpayer should be adjusted to account for the benefit accruing to IL Jin from utilising the funds generated due to credit purchases from AE which in turn bore no additional interest charges.
Tribunal’s Ruling:
- Based on the facts, the Tribunal queried on the timing when the sales were realised by IL Jin from its only customer (LG Electronics, India) and whether the Taxpayer was getting any benefit of utilising funds.
- However, due to Taxpayer’s inability to provide the required information substantiating/ supporting its claim, IL Jin’s contention was rejected by the Tribunal.
Issue 3: Quantum of adjustment attributable to the international transaction
Taxpayer’s Contention: Alternatively, the Taxpayer averred that while ascertaining the arm’s length price of the international transaction under TNMM, the total difference arising in operating profit cannot be exclusively attributed to the international transaction. In this regard, IL Jin invited the Tribunal’s attention to the fact that for manufacturing printed circuit board, IL Jin consumed 45.51% imported and 54.49% indigenized raw material. Therefore, the profit margin of 5.29% of sales should be applied in the same ratio (i.e., 45.51:54.49) to arrive at the arm’s length price of the imported raw material.
Tribunal’s Ruling: Based on the facts of the case, the Tribunal concurred with the Taxpayer’s appeal that only 45.51% of the operating profit arising from the sales can be attributed to the import of raw material and thereby directed the AO to reduce the adjustment proposed by the TPO.
Our Comments
The Tribunal has emphasised that the computation of adjustment should be with reference to international transaction. By attributing only a limited portion of the deficit in profit to the international transaction, the Tribunal has provided an implicit or tacit acceptance to the fact that a company can earn low-margins due to factors other than international transaction also.
Note:-
1. Includes, purchase of raw material (Rs. 4.75 crores), purchase of second hand goods (Rs. 0.42 crores) and repairing costs (Rs. 0.01 crores)
2. Has placed reliance on Aztech Ruling.
